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Posts Tagged ‘Lines Of Credit’
Wednesday, April 28th, 2010 by Tim Delaney
We stumbled upon these striking charts in an article in the Financial Times recently. It has interesting implications for credit analysis.
 The last decade’s boom in credit has been remarkable, led, of course, by mortgage-backed securities. But debt funding by companies is a close second, if you count “corporates” and “money-markets.”
There are plenty of reasons to believe the surge in corporate debt will continue. Equity’s miserable performance over the last ten years makes it much more expensive than debt, for one thing. And businesses in developing economies are hungry for capital, for another.
Although the article focuses on trading opportunities, debt markets move on a couple of drivers: technicals like changing interest rates and fundamentals like credit quality. After the market seizures of 2008, portfolio managers can’t be so confident they can trade their way out of a poor credit position. That means strong demand for credit analysis at origination and in the after-market.
Corporate loan and bond portfolios did not take the same drubbing as the mortgage-backed markets over the last several years, but doesn’t mean they were risk-free. At the worst, the global default rate on investment-grade bonds was 5.4% in 2009, and on non-investment grade bonds it was 13.0%. Commercial loan delinquencies in the United States were at a 4.5% rate at the end of 2009.
The debt markets got a memorable course of risk-aversion therapy recently, and they’re likely to remain acutely risk-conscious for some time. Regulators doubtless will be especially vigilant about credit risk as well.
Banks, investors, and traders who take credit risk will want to pay close attention to the fundamentals. Analyzing business risk, financial risk, and structural protections may not be glamorous, but it will be more important than ever.
Tags: Lines Of Credit, Sources and Uses
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Monday, October 19th, 2009 by Ron Carleton
In the last 6 months, we’ve seen a number of “amend and extend” transactions. Typically they involve:
- The extension of the maturity of a term loan and/or revolver (typically for syndicated, non-investment grade loans). This is only for lenders who agree to the extension (i.e. some lenders may keep the original maturity
- Increasing loan pricing for lenders who agree to extend (to reflect current market conditions and the higher credit risk of the borrower) and an amendment fee.
- Covenant relief for the borrower (reflecting operating performance below original the targets).
Why an Amend and Extend?
During normal economic times, a borrower would do a new syndication as the maturity date for an existing facility approaches. So why are we seeing amend and extend agreements rather than new facilities? Because many of these companies would have a hard time getting a new syndication done. The loan market is much more selective for high risk credits, and many of these companies have high leverage and weak cash flows.
Amend and Pretend?
It is clear why a borrower would want an amend and extend (despite the higher cost) – they get covenant relief and one or two more years to turn around the business and generate cash for debt repayment. But why are lenders agreeing to these transactions? Do they really believe the borrowers will be able to repay the loans 2 years later, or are they just deferring the day of reckoning – the day when the borrower will need to do a major financial restructuring (or even a bankruptcy) and the lenders will have to write down the value of the loans? Is it an “amend and extend” or “amend and pretend” (that the loan will actually be repaid some day)?
Tags: Amend and Extend, Covenants, debt structure, Lines Of Credit, Problem Credit, Turnaround
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Thursday, April 2nd, 2009 by Ron Carleton
Loans to non-investment grade and middle-market companies are typically secured by the borrower’s receivables, inventory, and fixed assets. Pledging this collateral, however, does not reduce the borrower’s likelihood of default. Security should reduce the loan’s loss given default, but not necessarily in the way you expect. Here’s how.
How Are Loans Repaid?
Banks that make secured loans do not expect to foreclose on the collateral to repay the loans. Loans are typically repaid from cash flow from operations or by refinancing with new debt. Foreclosing on collateral is a last resort. Some lenders, such as those that provide asset based loans, equipment finance, or mortgages, are expert in disposing of foreclosed assets, but most banks are ill-prepared to seize assets and sell them.
So Why Take Collateral?
Most secured lenders to bankrupt large corporate and middle-market companies never take possession of their collateral. Instead, the companies are reorganized or sold using the bankruptcy system (e.g. Chapter 11 or Chapter 7 in the U.S.). Proceeds from the bankruptcy, either cash or new securities, are then distributed to creditors. Secured creditors have a higher priority when these proceeds are distributed, giving them lower losses than unsecured creditors.
Does Collateral Mean the Loan Will Be Repaid?
Unfortunately not. Even if the value of the collateral exceeds the amount of the loan when it is made, it is likely that the value of the pledged assets will be substantially lower when the borrower is in financial distress. After all, an asset is only worth what someone will pay for it, and, as we’ve seen, many assets decline in value in a recession.
What’s the Lesson?
As a lender, by all means take collateral when you can get it – just don’t rely on the collateral as your primary (or even secondary) source of repayment. Instead, analyze the company’s ability to generate cash flow to repay its debt. Remember, taking collateral doesn’t mean the company or its assets will retain their values. Unless you are an asset based lender, the biggest benefit you get from collateral is that it moves you to the front of the line in a bankruptcy.
Tags: Bankruptcy, CAPS, debt structure, Lines Of Credit, Priority
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Monday, March 16th, 2009 by Ron Carleton
Wendy’s/Arby’s Group, Inc. (ticker WEN) was formed in September 2008 through the merger of the  Wendy’s and Arby’s fast food chains. In March 2009, WEN announced it had redone its main loan agreement to reflect the merger. Nothing unusual there. The surprise is that Wendy’s/Arby’s Group, Inc. is not a party to the loan agreement. Here’s why.
Holdco – Opco Structure
Wendy’s/Arby’s Group, Inc. is a holding company (”holdco“) – it has over 60 direct and indirect subsidiaries that actually own, franchise, or operate the restaurants (the operating companies, or “opcos“).
- The opcos have real assets (buildings, inventory, receivables, contracts, etc.) and hopefully generate cash flow from their operations.
- The holdco’s assets are stock in the opcos, and the holdco’s primary source of cash is dividends from the opcos.
A Quick Lesson on Bankruptcy
Under the absolute priority rule, a bankrupt company must repay its creditors (i.e. lenders, suppliers, employees, etc.) in full before it can distribute any cash to its owners. So, if WEN and its subsidiaries ever went bankrupt, who would be repaid first: lenders to the holdco (i.e. Wendy’s/Arby’s Group, Inc.) or lenders to the opcos (i.e. the 60 subsidiaries)? Answer: the opcos, since they have the assets and cash flow and must repay their creditors before paying dividends to the holdco.
Structural Subordination
The idea that opco creditors are paid before holdco creditors is referred to as structural subordination. Because of structural subordination:
- Lenders to high risk companies (such as WEN) often prefer to lend to operating subsidiaries rather than to a parent company.
- Loans to holdcos often include a subsidiary debt limitation and upstream guarantees in order to limit the impact of structural subordination.
- The rating agencies typically rate the debt of a holdco lower than the debt of its operating subsidiaries. For example, Standard and Poor’s rates Wendy’s/Arby’s Group, Inc. “B-” but assigned the slightly higher “B” to the loans of its subsidiaries.
Tags: Bankruptcy, CAPS, debt structure, Lines Of Credit, Priority, Subordination, Wendy's/Arby's Group
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Wednesday, December 31st, 2008 by Ron Carleton
After asking for $18 billion, General Motors is getting a $10 billion loan from the U.S. Government. They claim they’re running out of liquidity and they need the funds to survive through 2009. Are they right? Or is this just financial incompetence taking advantage of Congressional insecurity?
There’s no doubt GM has been using up its supply of cash. They’ve run through almost $9 billion in the first nine months of this year. That’s a cash burn rate of $32 million a day.
But cash doesn’t tell the full story. Liquidity is more than cash. It includes access to readily available credit, like lines of credit from banks that have made a legal commitment to lend.
GM began the year with $5.9 billion in committed bank lines, nearly all of which was unused. But by the end of September, the company had borrowed almost $5.8 billion under those lines, leaving only $114 million available to meet liquidity needs.
If we measure liquidity as cash plus un-borrowed, committed lines of credit, GM’s problems look even worse. GM has consumed more than $14 billion in liquidity through September, a liquidity burn rate of $52 million a day and $4.7 billion a quarter.
By March of next year, liquidity will be down to only $4.1 billion, according to the projections GM gave Congress. With hardly any credit available from the banks or the debt markets, it looks like GM is right. They really will run out of liquidity before the end of June 2009.
Tags: Cash Burn, General Motors, Lines Of Credit, Liquidity, Rescue
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